A THIRD PARTY IN YOUR REMARRIAGE CONTRACT - THE GOVERNMENT
By Margorie Engel, Ph.D., ©2000*
Public policies sometimes work to your detriment when you remarry. Federal and state laws may create difficulties when you are dealing with credit and debt, joint tax returns, changes in tax status, IRS refunds, alimony, property ownership, and capital gains. Since these policies were developed for first marriages, sometimes strange things happen when they are applied to remarriage and stepfamilies.
Credit and Debt
Divorce financial settlements are not binding on creditors. If you and a former spouse continue to have both of your names on a loan or account, you are at risk for each other's financial behavior. The most common example is continued responsibility for a house mortgage. The divorce judgment may have transferred the deed to your spouse. However, unless the mortgage was paid off or refinanced without you as a co-borrower, you continue to be liable for the timely and in-full mortgage payments. This continued financial connection to a former spouse may also occur with automobile loans and credit cards.
Take an inventory of your financial obligations. If you still have significant financial entanglements with a former spouse, it may be a good idea to keep your accounts separate from those of your new spouse. Obligations in one partner's name alone generally cannot be attached by the other spouse's creditors.
Horror stories abound of ex-spouses wiggling out of financial obligations by declaring bankruptcy. There is a misconception that bankruptcy, governed by both federal and state laws, dissolves all debts. It doesn't. Debtors still have bills to pay. Typically, they must still contend with car payments, house payments, and federal taxes. In many states, student loans, alimony, and child support must also be paid. Divorce decisions that are most vulnerable come under the heading of property distribution, not alimony or child support.
Joint Tax Returns
The IRS is watching your financial marriages even if you are not. Remarriage does not eliminate potential problems with the IRS and your former spouse. If you filed joint tax returns with your ex, you assumed responsibility for the accuracy of all the information, not just your portion. This includes items such as under-reported income and unjustified deductions. If the IRS successfully challenges information that you or your former spouse provided on the return, the IRS can come after you years later and attach whatever assets you hold—individually or with your new spouse. For this reason, many tax preparers advise people who bring substantial assets to a marriage to use the "Married, Filing Separately" format in an effort to protect them from each other's unexpected tax liabilities.
Changes in Tax Status
If your single household included children, you were able to compute your tax liability in a tax-favored status as Head of Household. A remarried woman loses this personal tax advantage. In addition, the "marriage tax" discourages two income marriages. It does this because couples tend to "simplify the tax code" by viewing the first dollar of the second spouse's income, usually the wife's, as taxed at the same rate as the last dollar of the first spouse's income, usually the husband's.
When both husband and wife are employed, one spouse earns considerably more than the other, and you file jointly, there are a couple of ways to handle the tax payments and distribute the refund. The simplest would be to apply a ratio of your income to your share of the taxes. However, the income tax system is progressive so a simple proportion may not be equitable. Another possibility is to agree that the spouse with the lower income will not pay more taxes than would have been paid when using the "Head of Household" schedule.
Maybe a Nice Tax Surprise
"You can deduct your moving expenses, subject to certain dollar limits, if your move is closely related to the start of work and if you meet the distance test and the time test." So says the IRS Publication 521, Moving Expenses. When, as a result of remarriage, you move and change jobs, this tax deduction might be available to the spouse who makes these home and career moves. In broad terms, if you find a new job within one year of the move and it is at least 50 miles farther from your former home than your old main job location, it may be a valid deduction. There are some detailed hurdles to pass but the potential savings make this worth checking out.
The IRS frowns on parents who fall behind in their child support payments and assists custodial parents in the collection process. Federal and state tax refunds can be intercepted. If your current spouse is delinquent and you filed a joint tax return, your portion of the refund may also be snagged.
You may be able to get your portion of the refund check by filing the "Injured Spouse Claim and Allocation Form #8379." To get a copy of this form, call (800) TAX-FORM. Refunds are distributed according to state law, not according to who earned them. Instructions on the current form indicate, "Generally, claims from [community property states] California, Idaho, Louisiana, and Texas will result in no refund for the injured spouse."
Most divorce agreements state that alimony payments permanently cease upon remarriage. There is no guarantee that you will be granted alimony from—or have to pay alimony to—your new spouse if this marriage ends. The focus now is on short-term rehabilitative alimony, if you were married "long enough." And, the timing is subjective.
Withholding Alimony Payments
Alimony is tax deductible to the payor and taxable income to the recipient. If you or your new spouse are withholding alimony payments for any reason, and still deducting the court-ordered alimony amount on the tax return, the IRS can go after back tax, penalties, and interest from both of you in this marriage—if you filed a joint return. Typically, withholding behavior occurs when alimony payments are being held as ransom until property is returned or legally transferred per divorce agreements. Be forewarned that the IRS receives many of its leads about tax irregularities from angry ex-spouses.
Taxes on Property
Older couples may remember the confusion about capital gains tax rollover provisions and a one-time exclusion $125,000 of gain from the sale of a principal residence for taxpayers age 55 or older. According to the 1999 U.S. Master Tax Guide, effective for sales and exchanges after May 6, 1997, this old formula has been replaced. The amount of the new excludable gain is increased to $500,000 for married individuals filing jointly, if they meet three criteria. First, at least one spouse must meet the ownership test—the individual must have owned the home as a principal residence for at least two of the five years before the sale or exchange. Second, both spouses must meet the use test of residing in the home for at least two of those five years. And, three, neither spouse is ineligible for exclusion by virtue of a sale or exchange of a residence within the last two years.
It is important to note that the new exclusion is determined on an individual basis and that it can be used on a continuing basis—but not more frequently than once every two years. If a single individual who is eligible for an exclusion marries someone who has used their exclusion within the prior two years, the newly married individual still is entitled to half ($250,000) of the exclusion. This eliminates the "tainted spouse" problem that, under the prior law, prevented an individual in a second marriage from making use of any portion of the old $125,000 exclusion if the other spouse had already used it.
The $250,000 or $500,000 exclusion from income eliminates the need for many homeowners to keep records of capital improvements that increase the basis of their residence. However, you will want to keep these records if there is any possibility that income might be required to be recognized upon the sale of the principal residence. For instance, your profit from the sale might be above $250,00 or $500,000 if your residence and those in the surrounding neighborhood are rapidly appreciating in value or you intend to live in the residence for a long period of time.
Miscellaneous Notes about Property
Combining two households worth of financial records can result in a rather large pile of papers. If you are selling a home and reporting the sale on IRS tax form #2119, generally all you need to keep are the settlement statements, a copy of IRS form #2119, and receipts for home improvements that were used to adjust your cost basis. Reminder: If you want to transfer ownership of real property, in part or total, to your new spouse, it must be conveyed in a legal fashion. This means recording the transaction with government authorities. Transfers done between spouses, after marriage, avoid creating a taxable event. Now that you've organized your household business papers, unpacked boxes, and hung the pictures, it's time for a House Warming Celebration!
* This article first appeared in Bride Again magazine, Spring 2000. Permission granted for use on the NSRC web site by Bride Again magazine.